Will selling season spring home-builder stocks?

JohnSpence

BOSTON (MarketWatch) -- Shares of home builders could see plenty of volatility ahead as nervous investors try to get a handle on whether the key selling season shakes out as a bust or the first step to a meaningful recovery in the housing market.

"As we move into the heart of the spring selling season, investors and analysts alike are anxiously monitoring housing market conditions for any signs of boom or gloom," wrote Citigroup analyst Stephen Kim in a report to clients this week.

"To some degree, this hunger for information is natural, since all winter long we have been subsisting on a meager gruel of statistically insignificant figures," he added.

Against this backdrop, investors are tearing apart each new batch of data for any clues, which is contributing to the stock price swings. During Tuesday's session, shares of home builders opened higher but then dropped after a midmorning report estimated U.S. pending home sales had fallen 4.1% in January, after rising the previous month. Stocks in the sector then bounced higher in afternoon dealings.

Until the home builders begin reporting their second-quarter home orders in another two or three months, the short-term moves in the sector "could be a bit hair-raising," wrote Citigroup's Kim.

In other words, investors who are banking on a housing sector bounce sometime in 2007 should buckle up for a potentially wild ride.

An exchange-traded fund that tracks home builders, the iShares Dow Jones U.S. Home Construction Index Fund
ITB, -1.20%
is down more than 14% this year, according to investment researcher Morningstar Inc. The sector's shares have been hit by reported losses, write-offs, lower sales and higher incentives to buyers.

"To say that the home building stocks are a volatile bunch is putting it mildly," said Kim, arguably one of the most bullish analysts following the sector. Encouraged by builders' moderating cancellation rates, he forecasts about 71% gains in the sector stocks over the next year.

Yet, he warned that "while strong spring sales would obviously strengthen our investment case, a disappointing spring could drive an unpleasant, short-term dip in the stocks."

Other risks include an economic recession, growing inventories of unsold homes on the market and higher mortgage rates.

Spring fever, subprime worries

The timing of the crucial home-selling season varies by area of the country and climate, but an unofficial kickoff is Super Bowl weekend.

"In general, we believe the spring selling season has been at least a mild disappointment for most; traffic levels seem firm, but sales activity soft," said analyst Carl Reichardt at Wachovia, which recently hosted a home-building industry conference in Las Vegas.

"Likely as a result of a so-far sluggish spring, we felt some builders seemed to be tempering their outlooks for their business," Reichardt wrote in a conference summary.

During a Web cast of last week's conference, Lennar Corp.
LEN, -2.21%
Chief Executive Stuart Miller said that while there are signs of firming in some parts of the housing market, the data are "erratic, with no clear signals" and there are still "some risks out there."

Builder CEOs also say they're wrestling with a glut of unsold homes on the market as a result of the speculative excesses during the go-go years. New mortgage products, such as interest-only loans, helped fuel the boom.

Faced with a tough market, builders are trying to shore up their balance sheets and scale back their land holdings.

"Today, [home] affordability is our No. 1 long-term issue," said Centex Corp.
CTX, +0.40%
CEO Tim Eller at the Wachovia event. "New-home prices have corrected in a number of markets, but only time can take care of the affordability issues."

Meanwhile, luxury-home builder Toll Brothers Inc.
TOL, -1.67%
said it didn't see any big jump in sales during the recent President's Day holiday weekend.

"We don't expect to see a turnaround in this selling season that many had expected," said Toll Chief Financial Officer Joel Rassman at an investment conference sponsored by Raymond James this week.

Aside from lackluster sales, another key issue facing home builders is the shake-out in the subprime mortgage market. Subprime mortgages are designed for home buyers who don't meet the strictest lending standards. Some of the largest subprime lenders have seen their stocks hit recently on regulatory investigations, higher interest rates, tighter lending standards and late payments from borrowers. See related story.

Builders, many of which have their own mortgage-lending units, don't appear to face much exposure to the subprime market, although anything that rattles buyer confidence is cause for concern.

"Subprime is not a big part of our market, but it has a big psychological impact," said Toll's Rassman. He said negative headlines on the subprime market "make customers nervous" and the housing market could feel some pain in the next month, from foreclosures and more speculators quitting the market.

"Most builders do not expect problems in the subprime market to spill into substantially tightened lending standards for the prime market, and on average, we believe builders feel that subprime customers represent 10% to 12% of total business," said Reichardt, the Wachovia analyst.

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